Ten years after the U.S. sank into recession, the U.S. economy is still benefiting from stimulative monetary and fiscal policy, said Jim O’Sullivan, chief U.S. economist for High Frequency Economics and the 19-time winner of MarketWatch’s Forecaster of the Month contest.

“The backdrop is quite accommodative for growth,” O’Sullivan said in an interview after winning the November forecasting contest. “Unless employment slows dramatically, the unemployment rate will go to 3.5%” in 2019. That would be a 50-year low for the jobless rate.

That would put a lot of pressure on the Federal Reserve to keeping raising short-term interest rates. Already, the unemployment rate has dropped to 4.1%, about a half percentage point below the assumed “full employment” rate. That’s the rate that’s consistent with stable prices; if it goes much below that for an extended time, inflation will heat up.

At least that’s the theory. There’s a robust debate among economists and policy makers about the exact relationship between inflation, unemployment and growth. Many so-called doves insist that the Fed shouldn’t raise rates aggressively until inflation actually accelerates. The Federal Open Market Committee has mostly followed the doves’ advice to go slow.

They say that the fact that wages are growing slowly proves that the economy isn’t at full employment yet, because if it were, employers would have to pay higher wages for scarce labor resources.

O’Sullivan’s answer is that consumer prices and wages only start to accelerate once the unemployment rate falls below 4.5% or so, and that only occurred this past spring. It takes time for the inflationary effects to show up.

The wage and price data are giving us "mixed signals,” he said. But he’s convinced that prices and wages are beginning to accelerate, and that the Federal Reserve will continue to raise short rates at a pace of about once a quarter. The federal-funds rate should hit 3.13% by the end of 2019.

In a recent note to clients, O’Sullivan argued that wage income is being undercounted in the official average hourly earnings data, which comes from the establishment survey and which is reported in the monthly payroll report. But more comprehensive data from the Bureau of Labor Statistics’ quarterly wage and employment report — based on actual payroll tax records — shows much stronger wage growth.

Usual weekly earnings are also growing, he noted.

He thinks consumer prices will gradually drift higher as well. “Workers have more bargaining power than companies have pricing power,” he said.

The tax cut moving through Congress should have a muted impact on growth, he figures. “It’ll add a few tenths” to the growth rate, he said. The major impact at first would be a small boost to demand, which isn’t really needed right now. “It’s not the time to do fiscal stimulus.”

Any boost to the supply side through increased investment would only come later.

Indicator

O’Sullivan’s Forecast

Number as Reported *

ISM

60.0%

58.7%

Nonfarm payrolls

340,000

261,000

Trade deficit

-$43.4 billion

-$43.5 billion

Retail sales

0.3%

0.2%

Industrial production

0.8%

0.9%

Consumer-price index

0.1%

0.1%

Housing starts

1.215 million

1.290 million

Durable goods orders

-0.5%

-1.2%

Consumer confidence index

127.0

129.5

New home sales

630,000

685,000

* Subject to revision

O’Sullivan has won our monthly contest 19 times in 14 years, including three times this year. He has won the Forecaster of the Year contest nine times, including the last six years in a row.

In the November contest, O’Sullivan’s forecasts on seven of the 10 indicators we track were among the 10 most accurate from the 45 forecasting teams in the contest.

The runners up in the November contest were Pat O’Hare of Briefing.com, Brett Ryan’s team at Deutsche Bank, Richard Moody of Regions Financial, and Jan Hatzius’s team at Goldman Sachs.

The consensus forecasts MarketWatch publishes in our Economic Calendar are the median forecasts of the 15 forecasting teams that have done the best in our contest over the preceding 12 months, plus the forecast of the most recent winner of the Forecaster of the Month. Our curated consensus is much more accurate than the Bloomberg consensus that’s widely followed.

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